'China's Reserves Have Fallen 3 Months In a Row'

Well here's a very positive development from my point of view and perhaps nearly everyone else's. China having an unfathomably huge $3.2 trillion in foreign exchange reserves may prove to be the apotheosis of a supremely wasteful activity. It is, to me, the largest financial folly in world history--and certainly in nominal amounts. This misallocation of capital has obviously not benefited China's citizens much in receiving public benefits but has fuelled wasteful excesses elsewhere such as funding American tomfoolery through the Afghanistan and Iraq misadventures as well as the subprime crisis.

While Chinese policymakers have long called for rebalancing their economy towards domestic demand, it has not really been evident over the years. Well things may be changing (at long last). Remember, too, that debates in China happen alike those elsewhere in the world between export lobbies that would like to maintain the status quo of dirt-cheap, essentially subsidized inputs and those favouring a more balanced form of growth. In any event, the notable observation in the Reuters wire report that follows is that China's reserves have fallen for three straight months in a row, though we won't know for sure until the official figures come out early next year:

A decline in China's foreign exchange reserves extended through November, providing a good chance for Beijing to speed up capital account opening, an advisor to the Chinese government said on Wednesday. Concerns about "hot money" inflows have long been cited as a reason for Beijing's caution in liberalising its carefully controlled capital account and foreign exchange regime.

But Li Yang, a deputy head of the Chinese Academy of Social Sciences and a former central bank adviser, said the concerns are no longer as potent as China's foreign exchange reserves had been falling every day for the last two months. "It provides a time window for China to speed up its necessary reforms, like capital account opening and yuan convertibility reform and even the exchange rate formation mechanism," Li told reporters.

For all the talk of yuan undervaluation, the currency has appreciated significantly in real terms as inflation remains a factor in China. Hence the ancillary issue of how to handle capital inflows. Moreover, the yuan is no longer a one-way bet as the powers-that-be allow it to move forwards and back nowadays...

China's foreign exchange reserves have expanded rapidly over the last decade, becoming the world's biggest in the process worth some $3.2 trillion, swollen by a huge trade surplus and strong capital inflows. The inflow has driven the yuan some 40 percent higher in real effective terms since China broke its peg to the U.S. dollar in a 2005 landmark reform. The People's Bank of China (PBOC) has managed appreciation carefully since to prevent the exchange rate from rising too sharply while maintaining steady upside.

But the situation had changed abruptly in the last two months as money started to leave China and the yuan began to weaken against the dollar in the onshore market. It has lost around half of one percent since marking a record high to the dollar on November 14 of 6.3354.

"It's still hard to say whether these changes will become trends, but one thing is clear, one-way capital inflow or one-way bets on a yuan rise have become history," Li said. He added that China's 50 basis point cut in the reserve ratio banks are required to hold -- announced on Nov. 30 -- was a move designed to cope with capital outflows and shrinking foreign exchange reserves.

"Foreign exchange reserves declined in September, October and in November -- they have been falling each day," he said.

You can have a lively debate on whether PRC reserves are falling out of (policy) choice or (economic) necessity as traditional export markets sputter anew. It may be a combination of both as the article implies as authorities make adjustments in anticipation of further softening of export performance. The EU is the PRC's largest export destination, remember. But it does look like more changes will be forthcoming in the form of diminished export performance, moderation of maniacal reserve accumulation, and hopefully more emphasis on domestic demand as well as a more liberal capital account. All the while the yuan will actually be subject to market forces--meaning it can depreciate as China's economic performance shifts.